All the Devils Are Here [115]
Instead, because Fannie wouldn’t buy riskier loans, its share of Countrywide’s business shrank. According to an internal Fannie Mae presentation, in mid-2002 Fannie bought more than 80 percent of Countrywide’s mortgages. By early 2005, that had shrunk to about 20 percent. “This trend is increasingly costing us business with our largest customer,” noted the presentation.
The new, tougher housing goals of the Bush administration also ratcheted up the pressure. How was Fannie going to achieve those goals without adding subprime mortgages to its books? The products it had carefully tailored for low-income borrowers were no longer appealing in a world where those borrowers could get much bigger mortgages from a subprime originator by making up their income. But Fannie couldn’t just dive headlong into the subprime market. Its systems weren’t able to gauge the risk of subprime mortgages. “[W]e are not even close to having proper control processes for credit, market, and operation risks,” wrote the company’s chief credit officer, Enrico Dallavecchia, in an e-mail. The irony was painful: HUD had increased and toughened Fannie’s housing goals at the precise moment when the market was willing to make loans—often terrible loans that quickly soured, to be sure—to any low-income person who wanted one. “The difference between what the market produced and what we had to produce grew bigger and bigger,” says a former Fannie executive.
“All these voices on the outside were saying, ‘You are not relevant,’” Mudd later recalled. “And you have an obligation to be relevant.”
Fannie’s traditional arrogance soon gave way to angst; Mudd would later say that going to work felt like “a choice between poking my eye out and cutting off a finger.” Fannie’s internal struggles were on vivid display at a getaway for executives in the summer of 2005. In a slideshow entitled “Facing Strategic Crossroads,” the first question Fannie asked itself was “Is the housing market overheated?” The next question: “Does Fannie Mae have an obligation to protect consumers?” Executives debated whether the new dominance of subprime products was a permanent change or a temporary phenomenon. The presentation went on to lay out the two “stark choices” Fannie faced. One was to “stay the course,” which meant staying away from subprime lending and seeing continued market share declines. The other: “Meet the market where the market is.” Which meant subprime. The presentation concluded on a plaintive note. “Is there an opportunity to drive the market back to the thirty-year FRM [fixed-rate mortgage]?”
Although the company vowed at the meeting to stay the course, in truth it had already begun to stray. First the GSEs bought for their portfolios the safest subprime securities in the marketplace: the triple-A-rated tranches of residential mortgage-backed securities. (Neither GSE ever bought CDOs.) They’d begun buying these securities in the earlier part of the decade because they offered decent yields. But when the housing goals became harder to fulfill, the triple-A tranches provided an easy way to meet their mission numbers. Eventually, the Street began designing a special GSE tranche that was packed with loans that satisfied the affordable housing requirements. And HUD allowed the GSEs to count these purchases toward their goals.
Over time, Fannie and Freddie became two of the world’s largest purchasers of triple-A tranches. In the peak year of 2004, the GSEs bought about